Insurance Planning, Chapter 1: Risk Management & Characteristics of Insurance

Flashcards covering key vocabulary terms and definitions from Chapter 2: Risk Management & Characteristics of Insurance.

Personal Risk Management Process

A seven-step process involving identifying, evaluating, and managing pure risk exposures faced by a client.

Risk Avoidance

A response to managing risk that involves avoiding an activity altogether to prevent potential losses.

Risk Reduction

A response to managing risk that involves implementing activities to decrease the frequency and/or severity of losses.

Risk Retention

A response to managing risk that involves personally bearing the potential for a loss exposure.

Risk Transfer

A response to managing risk that involves shifting the risk of loss to another party through means such as insurance or a warranty.

Peril

The proximate or actual cause of a loss, such as accidental death, fire, or collision.

Physical Hazard

A tangible condition or circumstance that increases the probability of a peril occurring and/or the severity of damages that result from a peril.

Moral Hazard

A character flaw or level of dishonesty a person possesses that causes or increases the chance for loss.

Morale Hazard

Indifference to losses based on the existence of insurance.

Unilateral Contract (Insurance)

A characteristic of an insurance contract where only the insurer makes a legally enforceable promise to perform.

Aleatory Contract (Insurance)

A characteristic of an insurance contract where the amounts paid in by the insured and paid out by the insurer may not be equal.

Adhesive Contract (Insurance)

A characteristic of an insurance contract where the insured had no opportunity to negotiate terms; thus, ambiguities are charged to the insurer.

Utmost Good Faith

A principle of insurance contracts requiring the applicant to be truthful in disclosing pertinent material facts and the insurer to disclose critical contract information.

Principle of Indemnity

An insurance principle asserting that an insurer will only compensate the insured to the extent of an actual financial loss, preventing the insured from making a profit from a claim.

Insurable Interest

A financial stake or relationship that an individual must have in the subject of an insurance policy to obtain coverage.

Conditional Contract (Insurance)

A characteristic of an insurance contract where the insurer's promise to pay is conditioned on the insured abiding by all policy terms and conditions.

Pure Risk

The chance of loss or no loss occurring, with no possibility of experiencing a gain.

Speculative Risk

The chance of loss, no loss, or a profit, typically not insurable.

Subjective Risk

The risk an individual perceives based on their prior experiences and the severity of those experiences.

Objective Risk

The variation of actual losses that occur over a period of time compared to the expected amount of losses; it reduces as the number of loss exposures increases.

Law of Large Numbers

A principle stating that actual outcomes will approach the mean probability as the sample size increases, useful for insurance companies in forecasting losses.

Ideally Insured Risk

A risk that meets requirements such as a large number of homogeneous exposures, accidental losses, measurable losses, non-catastrophic to the insurer, determinable loss probability, and a reasonable premium.

Elements of a Valid Contract

Requirements for a valid contract including mutual consent, offer and acceptance, performance or delivery, lawful purpose, and legal competency of all parties.

Conditional Acceptance (Insurance)

An insurance agent's acceptance of a life insurance application and premium, upon final review and approval by the underwriter.

Parol Evidence Rule

A legal rule stating that 'what is written prevails,' meaning any oral agreements prior to writing the contract are incorporated into the written contract and not independently valid.

Subrogation Clause

A clause in an insurance policy requiring the insured to relinquish a claim against a negligent third party if the insurer has already indemnified the insured, entitling the insurer to seek a claim against the third party.

Insurable Interest (Property and Liability Insurance)

Must exist both at the inception of the policy and at the time of loss.

Insurable Interest (Life Insurance)

Need only exist at the inception of the policy.

Representation (Insurance)

A statement made by the applicant during the insurance application process, which can be an oral statement or information disclosed on the application.

Warranty (Insurance)

A promise made by the insured that is part of the insurance contract, typically a promise to perform or take a certain action.

Concealment (Insurance)

When the insured is intentionally silent regarding a material fact during the application process, which may give the insurer the right to void the contract.

Express Authority (Agent)

Authority given to an agent through a formal written document.

Implied Authority (Agent)

The authority that a third party relies upon when dealing with an agent based upon the position held by the agent and surrounding circumstances.

Apparent Authority (Agent)

When a third party believes implied or express authority exists, but no actual authority exists.

Insurance Agent

A legal representative of an insurer, acting on behalf of the insurer, permitted to sell policies written by their company and bind the insurer.

Insurance Broker

A legal representative of an insured, acting in the best interest of the insured, who may sell policies from different insurance companies but may not bind an insurer.

Underwriter

An individual responsible for evaluating risks, determining insurability, and managing adverse selection.

Adverse Selection

The tendency of those that need insurance (typically higher-risk individuals) to seek it out, which underwriters manage to minimize policy issuance to less desirable applicants.

Insurer Risk Transfer

An action by an insurance company to reduce its exposure to catastrophic financial risk, often by ceding some of its risks to a reinsurer, or to create capacity to underwrite new policies.

Definition Section (Insurance Contract)

A section of an insurance policy that defines key words, phrases, or terms used throughout the contract.

Declarations Section (Insurance Contract)

A section of an insurance policy describing what property or individuals are being covered, including details like address, owner, coverage amount, deductible, and premium.

Description Section (Insurance Contract)

A section of an insurance policy that describes exactly what is being insured, such as the name of the insured for life/health or the address for property/casualty.

Perils Covered Section (Insurance Contract)

A section of an insurance policy that may list specific covered perils (named peril basis) or cover all risks of loss not specifically excluded (open peril basis).

Exclusion Section (Insurance Contract)

A section of an insurance policy that lists certain perils, losses, and property that are not covered, often due to being uninsurable, involving moral hazard, or being potentially catastrophic to the insurer.

Conditions Section (Insurance Contract)

Provisions in an insurance policy that require an insured to perform certain duties; if violated, the insurer may refuse to pay the claim.

Endorsement (Property Insurance)

A modification or change made to an existing property insurance policy.

Rider (Life or Health Insurance)

A modification or change made to a life or health insurance policy.

Deductible

The first dollar in loss that the insured is responsible to pay, serving to reduce small claims, lower premiums, and eliminate moral/morale hazard.

Coinsurance (Property Insurance)

A provision in a property insurance policy requiring the insured to maintain a stated percentage of minimum coverage; otherwise, the insured must proportionately share in a loss.

Actual Cash Value

Represents the depreciated value of property, used to determine the amount of coverage for items like personal auto or personal property.

Replacement Cost

The amount to repair or replace property without any deduction for depreciation, commonly used to value damage to a personal residence under a property insurance policy.

Appraised Value

A method of valuation used for hard-to-value items or property where the insured owns items that exceed standard limits within a property insurance policy.

State Government Regulation of Insurance

The insurance industry is highly regulated by three levels of state government: legislative, judicial, and executive (State Insurance Commissioner).

NAIC Goals

The goals of the National Association of Insurance Commissioners (NAIC) include protecting the public, promoting competition, fair treatment of insurance consumers, solvency of insurance companies, and supporting/improving state regulation of insurance.

Prior Approval Law (Insurance Rates)

Requires an insurance company to file a rate increase request with the state insurance commissioner's office and receive approval before implementing the rate increase.

File and Use Law (Insurance Rates)

Allows an insurance company to file a rate increase with the state insurance commissioner's office but immediately implement the rate increase.

Use and File Law (Insurance Rates)

Permits an insurer to increase rates, but they must file the rate increase within a specific time period as determined by state law.

Open Competition Laws (Insurance Rates)

Allow insurers to set their own rates, presuming that supply and demand will determine the appropriate rates for various insurance products.

Frequency of Losses

Measures the number of losses expected to occur.

Severity of Losses

Measures the potential size of losses in dollars.